Apple Cash Pile Sets Off a Battle

Apple Inc. Chief Executive Tim Cook is facing a new reality: delivering steady results from one of the world's most valuable companies is no longer good enough.

For nearly 18 months, Mr. Cook has kept a stream of new products rolling, produced a string of robust quarterly results and introduced a dividend and stock buyback expected to cost $45 billion over three years.

But an attack from one of Apple's prominent investors underscores how that approach may not be enough anymore, especially amid intensifying industry competition and the company's slowing growth.

ENLARGE

On Thursday, hedge fund manager David Einhorn sued Apple in a New York federal court in an effort to block an Apple shareholder proposal that he argues could limit how the company could return some of its $137 billion cash pile to investors. Apple is proposing to require a shareholder vote before it can issue preferred stock, a kind of security that Mr. Einhorn is urging the company to adopt. Apple's board already has the right to issue such shares, but said in a filing it doesn't intend to do so.

The proposal comes to a vote at Apple's annual shareholder meeting on Feb. 27.

Mr. Einhorn, whose firm Greenlight Capital Inc. and its affiliates own about $610 million worth of Apple stock, argues that Apple should distribute a "perpetual preferred" stock that could pay a dividend yield of 4%. The shares would return cash to shareholders by paying a bigger yield than Apple's regular shares, which currently carry a 2.3% dividend yield, according to FactSet.

The preferred stock dividends would only require Apple to pay out small amounts over time, rather than tapping its cash reserves to spend a large sum at once in the form of a special dividend or stock buyback.

More

"It's a unique solution to a problem that's been intractable—how does Apple reward its shareholders?" Mr. Einhorn said in an interview. "This idea allows them to keep their cash and yet enables shareholders to recognize value."

Apple later fired back in a statement Thursday, asserting that passage of the proposed shareholder measure wouldn't prevent Apple from issuing preferred stock in the future. Apple said it would evaluate Greenlight's proposal to issue the security and that its management team and board have been in "active" discussions about returning more cash to shareholders.

Apple's statement didn't address the merits of Greenlight's lawsuit, which argues that Apple is violating a securities rule by bundling three items—including the preferred stock matter—under one proposal.

The fracas encapsulates the growing investor unease about Apple as the company stands at a growth crossroads.

When Mr. Cook took over as CEO in 2011, investors widely believed he would be more receptive to distributing some of its cash, something that his predecessor, Steve Jobs, had fiercely resisted. In March 2012, Mr. Cook announced Apple's first dividend since 1995 and a stock buyback, and made a dividend payout last August.

But that hasn't appeased many shareholders as Apple's historical growth streak has tempered amid signs that the company is losing its competitive edge in smartphones to Samsung Electronics Co.

Concerns are also rising over an apparent lack of new game-changing products—like the iPad and the iPhone when they first debuted—which have previously driven Apple's growth. Mr. Cook has said the company continues to innovate at a rapid pace.

Last month, Apple reported a flat profit for its most recently ended quarter and executives predicted that revenue growth would continue to slow.

All of that has boiled over into a stock decline and increasing pleas by investors to put more cash to use.

David Einhorn is urging shareholders to vote against a company proposal that would eliminate preferred stock at Apple. David Benoit reports on Markets Hub. Photo: Getty Images.

Since closing at a record high of $702.10 in September, Apple's shares have dropped 33%. The stock rose Thursday after Apple's statement, finishing the day up 3% at $468.22.

Apple's cash hoard, meanwhile, continues to grow rapidly. As of the end of December, the Cupertino, Calif., company's cash sat at $137.1 billion, up 68% from the end of fiscal 2011. More than two-thirds of that amount is held overseas.

"A lot of people now feel the crisis is largely behind us, and want companies to start investing in growth and creating value," said Craig Orchant, partner at EA Markets LLC, a boutique capital markets firm. "There's now a much less tolerant view of enormous cash balances."

Some shareholders on Thursday applauded Mr. Einhorn's move. David Rolfe, portfolio manager of the RiverPark/Wedgewood Fund—in which Apple is the biggest holding—said he appreciates Mr. Einhorn's intent to get the iPhone and iPad maker to distribute more cash to shareholders.

Apple has "so much cash that it's literally forcing their hand," Mr. Rolfe said. "I understand being conservative is part of their culture, but c'mon, how conservative can you be?"

Investor David Einhorn has come out against an Apple proposal to eliminate preferred stock. What's the analyst take on it? Global Equities Research analyst Trip Chowdhry joins digits. Photo: Getty Images.

Still, issuing preferred stock would be an unusual maneuver, said corporate finance experts. Most companies use share buybacks or pay special dividends on their common stock to return excess cash to shareholders. Preferred stock is often issued by banks that don't want to issue debt that can affect their credit rating, or by utilities whose investors generally expect income rather than growing earnings.

The stock is generally designed for investors who want a steady stream of payouts with less exposure to earnings volatility. Perpetual preferred stock can trade like common stock. But unlike common stock, the shares usually don't have voting rights. They are called "perpetual" because the company is under no obligation to redeem them, as is the case with most bonds.

Some said the very idea that Apple should issue "perpetual preferred" shares suggests the company is no longer seen as a growth stock.

"Doing something like this runs a huge risk of entrenching in investors' minds the perception that Apple has become a value company," said Anant Sundaram, a professor of finance at the Tuck School of Business at Dartmouth who personally owns Apple shares.

As of 2012's fourth quarter, 25.1% of the institutional investment funds that owned Apple had a growth focus, down from 27.6% in the fourth quarter of 2010, according to Ipreo, a capital markets advisory and data firm. Value investors represented 39.7% of the institutional funds in the fourth quarter, up from 36.2% two years ago.

Mr. Einhorn said he brought Apple executives the idea for issuing a security last summer and the company dismissed it in September.

Apple may have at least one ally against Mr. Einhorn on the shareholder proposal. Calpers, the nation's largest public pension fund and a loud voice on corporate governance, said this week in a public filing it is supporting Apple's proposal that included the preferred stock change.

Apple proposed the preferred stock amendment after a broader review of its corporate governance practices and independent of Mr. Einhorn's proposal, people close to the company said.

If it were to succeed with the proposal, Apple would become an outlier. According to FactSet SharkWatch, 95% of all companies in the S&P 500 have the "blank check" provision for issuing preferred stock without a shareholder vote that Apple is attempting to toss out.

In a letter to Apple shareholders, Mr. Einhorn took care to also compliment the company—and, obliquely, Mr. Cook. "We believe Apple is a phenomenal company filled with talented people creating iconic products that consumers around the world love," wrote Mr. Einhorn.

—Gregory A. Zuckerman and Steven Russolillo contributed to this article.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.